Painful memories of the overenthusiastic participation of mutual funds (MFs) in the IPOs of new-age internet-based companies, such as Paytm (One97 Communications), Zomato, CarTrade and PB Fintech, continue to haunt retail investors. There were concerns about the high valuations of these companies and the stocks plunged on their listing day. Mamaearth, though, made a lacklustre debut on BSE on Tuesday, a modest premium of 1.85% to the issue price of ₹324,
Investors have now begun to question the wisdom of MF investments in startup IPOs. To be sure, the exposure of these funds is well below 1% of the total AUM (assets under management) of a scheme. However, some funds have had concentrated positions in these stocks as well.
Fund houses can participate in an IPO either as anchor investors or as institutional investors in the general quota for qualified institutional buyers (QIBs). As per norms, 5% of the shares need to be allocated to MFs in the QIB quota. Companies have the option to sell up to 60% shares of the QIB book to anchor investors, one-third of which has to be reserved for mutual funds, subject to demand. In India, any anchor investment (including by mutual funds) is subjected to a 30-day lock-in period for 50% of their investment and a 90-day lock-in for the balance 50%.
The IPO game
IPO activity has surged in the country over the last six months. Notably, companies spanning 18 different sectors have successfully raised funds in the past three years through the IPO route.
Mutual funds have been strategically engaging in this IPO game. One common route is to allocate a small portion of their AUM in their flagship funds to such offerings. Alternatively, they may take a more substantial stake in IPOs through smaller thematic schemes. To manage risk and capitalize on opportunities, mutual funds often exit their positions after the lock-in period ends, especially if the stock value declines. However, if their conviction in a particular IPO remains strong, they may choose to average down their stock position. Additionally, if the right opportunity presents itself, they may re-enter the stock, in a bid to navigate the dynamic IPO landscape effectively.
Alpha from IPOs
The performance of IPOs on their listing day has varied this year. Data from Bloomberg shows that 16% of companies that listed on the bourses experienced negative returns, 27% had returns of up to 15%, and a substantial 57% overperformed, leading to returns exceeding 15%. Listing gains constitute a significant portion of the returns generated from an IPO. These gains reflect the difference between the issue price and the stock’s opening price when it starts trading on the exchanges.
Financial experts say that success in the IPO market is not just about seizing short-term gains; it’s about identifying companies with the potential to become future multi-baggers. Since 2016, the IPO market has seen significant shifts in company sizes. Seven small-sized companies successfully grew to become large-sized corporations, while 36 others advanced to midsize status. Additionally, eight midsize companies expanded into large-sized entities. However, three midsize companies faced downsizing. In a notable change, one large-cap company transitioned to mid-cap status.
This data from Edelweiss AMC reinforces the idea that the right selection, impeccable timing, and prudent position sizing are all equally critical components in capturing the full spectrum of opportunities presented by the ever-evolving IPO market.
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Nehal Mota, co-founder and CEO of Finnovate, a Sebi-registered RIA, said that mutual funds have always been doing due diligence before such investments. “Firstly, they check out the valuations of companies before becoming anchor investors. Valuations are difficult to arrive at for new-age companies but proxies like EV/Ebitda are used. Secondly, they evaluate the size of the IPO and post-issue float. MFs have been generally wary of IPOs that are very large or are likely to see substantial equity dilution. Lastly, mutual funds look at credible business models with market momentum before an anchor investment.”
EV is short for enterprise value and Ebitda stands for earnings before interest, taxes, depreciation, and amortization.
The IPO fund
People who want to invest in IPOs and earn additional returns but fail to get allotment in the retail segments can check out the Edelweiss Recently Listed IPO Fund. The fund’s investment strategy focuses on capturing gains from the listing and post-listing of the most recent 100 IPOs, particularly in new-age Indian businesses across sectors, with an emphasis on small and mid-cap companies poised for growth.
This fund has consistently outperformed the Nifty 50 Total Return Index (TRI) over various timeframes. In the last year, it returned 17.0% compared to the Nifty 50 TRI’s 16.1%. Over three years, the fund generated a return of 24.1%, surpassing the Nifty 50 TRI’s 21.9%. Over five years, it achieved a return of 19.2%, while the Nifty 50 TRI returned 13.8%. Since inception, the Edelweiss fund has yielded a strong return of 14.14%.
The investment rationale
MFs have seen both hits and misses in terms of their investments in new-age internet-based stocks, right from their IPO days. Some funds have been wary after booking losses that extended upwards of 60-70% on their investments but others have maintained their conviction and doubled on the stocks in their portfolio during huge drawdown periods.
While one can question the rationale behind investing in these startups , the damage caused by these positions is negligible at an overall AUM level of most of these funds.
“Such exposure may simply be a strategy of fund houses to deploy fresh money in new-age sectors more as a learning curve than very serious wealth creation. These exposures seldom have any negative impact if they fall post IPO (given the low exposure) and can marginally help performance if they turn out to be multi-baggers. An investor should not evaluate mutual funds based on such exposure.Anchor investing should not be taken as a cue for investors, either to invest in such stocks or in the fund or otherwise,” said Vidya Bala, co-founder, Primeinvestor.in